Real Estate Investors Face Challenges Today

HOUSTON – (Realty News Report) – Andrew Pappas talks challenges real estate investors are facing today.

Pappas is managing director of Partners Capital and a shareholder in NAI Partners. He is responsible for building a platform that allows its investors to capitalize on NAI’s extensive market knowledge to generate attractive, risk-adjusted returns. Through Partners Capital, Andrew is assembling a significant portfolio of value-add office and industrial real estate. Prior to joining NAI Partners, he served as vice president at Vista Private Equity Group in Houston.

Andrew Pappas was a guest on THE RALPH BIVINS PROJECT produced by Realty News Report. To hear the entire podcast CLICK HERE.

Here is an excerpt from his appearance:

Ralph Bivins: What is the pathway to making money with real estate investing right now in 2021? Retail has its share of trouble. With apartments, landlords are having difficulty collecting rent. The industrial sector is doing pretty well. In the office sector, Houston has the worst vacancy rate in the nation. Today, we are fortunate to have Andrew Pappas with us. To start the discussion: Offices in Houston. Is this the right time and right product for real estate investors to be looking at?

Andrew Pappas: That’s a loaded question. Office in Houston? There are many different flavors. We have been dealing with strains of that product in the Houston market for 5-6 years. With our tenant rep team, we are on the job every day, in the trenches, working with tenants on restructuring, downsizing and moving. We are getting a front row seat on how the mentality is changing for tenants. It’s interesting that prior to COVID, the idea for office space was more density, the open concept, getting everyone close together and getting people out of private offices. In the post-COVID world, this will change. A lot of downsizing is taking place, especially in oil and gas-exposed tenants, which makes up a substantial part of the Houston market, either directly or indirectly. Now, you compound COVID with the macro-economic re-evaluation of how tenants are using this space. You can see two extremes. If you’ve read the papers or seen the news, especially during the past six months, you get the impression that no one will ever set foot in an office again. That won’t happen. What will happen, in the end, lies somewhere in between. Full work-from-home is not as scalable and robust on a blanket basis. When it comes to investing in Houston and the office market, one thing becomes clear and that is the flight to quality. Right now, there is a 26% vacancy rate in the nation’s third largest city, but there are 4.1 million SF of brand-new, shiny office space available. According to NAI’s latest study, 45.6% of the 4.1 million is already spoken for. The average rent for Class A buildings is $41.72. The average in Houston is $29.00 – gross. So, it’s not a small premium, there’s a substantial premium, and there is the flight to quality. My feeling is what is intrinsically a good product will always be a good product.

I think that with new buildings arriving, the older buildings, the ‘80’s vintage buildings, will have to innovate. There will be too much of a difference between the old stuff and the new stuff. Landlords need to be good operators; they need to think of amenities, of polish, of curb appeal. Consider the buildings that are now considered B+ or A-. Within five years, your A building is going to turn into a B building quickly. The dynamic shift of flight to quality will show itself in people being very careful and very intentional about their investments; they will watch their overhead. You can’t be asleep at the wheel. People want to invest in quality space.

Ralph Bivins: So, this means a challenge for landlords with older buildings.

Andrew Pappas: Class B and C level landlords will have to put money into their products. They must be competitive. There will be opportunities for investments, but people must be careful not to catch a falling knife. There are too many unknowns to use a pre-COVID policy when evaluating a deal. You will have to have the right-sized office compared to flex, industrial and retail. The amount of money you spend to increase your ROI has to be the right amount. You don’t want to purchase property at $100 a foot if it is going to cost you $100 or $120 a foot to bring it into compliance on a variety of levels, especially in a market where the tenant has the leverage.You can’t go into an investment without a coffer of cash to be prepared not only to weather the storm, but to continue until the market stabilizes. That is not “if”, but “when” the market stabilizes, which may be one, five or seven years. You have to have the cash on hand when the people come to make the deal. This is one of the biggest challenges when evaluating these opportunities.

Ralph Bivins: I see what you mean. Why wouldn’t you want to locate in one of the new buildings?

Andrew Pappas: The only way a B or C product can be competitive is price. And in a market where price is being beaten to hell, how can you be more competitive, especially with the number of concessions that landlords are giving out to bring in tenants. You eventually reach a point of no return.

Ralph Bivins: Elevating a Class C building to Class B could require a lot of work.

Andrew Pappas: There has been an evolution in construction, in materials, technology and infrastructure over the past 15 years. I recently heard an interesting presentation at the Amegy Bank Building and took a tour of the structure at the Galleria when the bank was completed. It took them 20 minutes to talk about how incredible the air filtration system was. And this was a pre-COVID project. They told how the air system is integrated through the floor along with a recirculation system and UV lights. Four million SF of new product coming on board in Houston will only highlight the age of the B and A- buildings. Those landlords will have to be hands-on, good owners and tenant focused. For B and C buildings, the determining factor will be the price. That’s the shiny object, the carrot to dangle in front of potential tenants.

For more about Texas real estate, check out the book Houston 2020: America’s Boom Town – An Extreme Close Up by Ralph Bivins. Available on Amazon http://tiny.cc/4a2g6y

File: Challenges Facing Real Estate Investors Today

File: Capital Partners. NAI Partners.